Economists React: The Fiscal Cliff ‘Can’t Be Fully Avoided’

By

Kate Milani

Nov 20, 2012 11:38 am ET

The countdown to the “fiscal cliff,” the across-the-board spending cuts and tax increases scheduled to hit at year-end unless Congress and President Barack Obama agree on an alternative, has begun. Economists and others weigh with their opinions about U.S. fiscal policy and predictions about how negotiations between the president and congressional Republicans will shake out.

–Maintaining the existing law, where all of the tax cuts expire and the sequestration [$1.2 trillion in automatic cuts to federal spending] goes into effect, would have a significant impact on economic growth, bringing our estimated 2.2% baseline economic growth rate for fourth quarter 2013 to an abysmal 0.0% rate. The severity of this outcome re-enforces the need for policy makers on both sides of the aisle to step up and make tough decisions about the future of tax policy and federal spending, especially spending on entitlement programs [primarily Social Security, Medicare and Medicaid]. The faster Congress and the administration address these challenges, the sooner the U.S. economy can begin to slowly return to trend growth. –John E. Silva, Michael A. Brown and Kaylyn Swankoski, Wells Fargo Securities

–Timing matters. The current fiscal cliff represents a danger due to both the speed and magnitude of the tightening [of fiscal policy] … longer-term proposals, such as the President’s recently announced plan are preferable as they are less abrupt. The long-term effects of the proposed $1.6 trillion, 10-year tax increase would create between 90 and 120 basis points of equivalent Fed tightening each year (excluding any interest rate lowering effects from deficit reduction) … as growth accelerates in 2013 and 2014, it would appear to make sense that tighter fiscal policy be put into place, not just for the positive impact on the deficit, but also because such an action may be the only way for the Fed to extract itself from its quantitative easing programs. –Drew T. Matus, UBS Investment Research

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